Next up: The Grinch

Next up: The Grinch

Santa sightings will be scare this Holiday Season, as a bevy of national retailers grapple with the economic downturn. Bankruptcy experts say liquidations will be a big theme.

retail by Tiffany Kary and Christopher Scinta | Bloomber News

In the last quarter century, about a fifth of large retailers that went bankrupt, including RH Macy & Co. Inc. and FAO Schwarz, did so in January, using holiday sales cash to jump-start reorganizations or finance liquidations.

This bankruptcy season is different. Retailers with reduced revenue or bloated debt are closing down early because of a consumer spending slump linked to the credit crunch, dwindling inventory values and restrictive changes in the bankruptcy law, said Jonathan Henes, a lawyer at Chicago-based Kirkland & Ellis. More liquidations are coming, he said.

"There's going to be tension between allowing retailers to get through the holiday season versus liquidating in December where a lender may have the best chances of getting repaid," said Henes, who specializes in bankruptcy law.

Value City Department Stores LLC, an operator of 66 discount stores, jumped the January gun and already filed for bankruptcy Oct. 27, saying it would conduct closeout sales. Three companies already in bankruptcy - Linens 'n Things Inc., the housewares retailer, Shoe Pavilion Inc., and Mervyns LLC, a department store chain, announced this month they'd liquidate, not reorganize.

The wait-till-January tactic, employed by Kmart Corp. and jewelry retailer Zale Corp. in years past, was designed to build up a war chest to attract investors as part of a reorganization or to pay off lenders that might then provide bankruptcy financing, lawyers said. Holiday sales sometimes helped avoid bankruptcy if companies got lucky with a buying spike.

Dried-Up financing

Tight credit markets have dried up bankruptcy financing - so-called debtor-in-possession or DIP loans, Henes said. Without DIP loans to finance a reorganization, companies will be forced to go out of business. The incentive to soften up lenders with payoffs aimed at getting DIP loans doesn't apply now, said Martin Zohn, a bankruptcy lawyer at New York-based Proskauer Rose.

Among distressed companies, electronics retailer Circuit City Stores Inc. said it is still considering "all available options" as it starts liquidation sales on Nov. 5 to close 155 of its stores following six straight quarters of declining sales. Department store Boscov's Inc., already in bankruptcy, is hoping to find a buyer to avoid liquidation. Borders Group Inc. has so far been unsuccessful in its efforts to find a buyer to rescue it from $11 million in second-quarter losses, a lack of financing and tough competition. Retailers with distressed bonds tracked by Bloomberg include Finlay Fine Jewelry Corp., Rafaella Apparel Group., Tampa-based Lazydays RV Center Inc., True Temper Sports Inc., Claire's Stores Inc., Dillards Inc., Burlington Coat Factory Warehouse Corp., Michaels Stores Inc., and Rite Aid Corp.

From 1980 to 2008, of the 105 large public retailers that filed for bankruptcy with assets of more then $100 million, only seven did so in December, giving up the full benefit a holiday cash infusion, according to statistics compiled by Lynn LoPucki, a law professor who teaches at Harvard University and the University of California.

That was less than half the 18 that did so in January - the most popular filing month for large retailers - and slightly less than the ten that filed in February after January clearance sales, he said.

"Seventy to 80% of bankruptcy filings in the retail sector traditionally take place at the end of high selling seasons," said Albert Nassi, a managing member at Tiger Capital Group LLC, a retail liquidation contractor since 1972.

Not anymore.

"Things have changed," he said. "Credit has tightened substantially, and the companies along with the creditors are finding that if they wait, the value of the inventory is going to be substantially lower."

Inventory pressure

Companies specializing in electronics, jewelry, clothing, and other popular gift items would benefit more from a pre- Christmas liquidation, while inventory values for items like furniture and other holiday items are actually higher in January, he said.

Tiger Capital, which has helped Linens `n Things and Value City liquidate, estimates that companies that liquidate in November or December may get 10% to 20% more than if they wait until January, when consumers' gift-giving impulses are over.

"Confidence has deteriorated so badly that merchants and bankers don't even believe in Santa Claus any more," Zohn said.

J. Scott Victor, senior managing director at National City Capital Markets, said that if a retailer is severely distressed with debt payments, a cash shortage or sagging sales, liquidating before Christmas is "a better alternative" than waiting.

Gordon Brothers Group, a financial and liquidation adviser, is "actively talking to potential clients who are looking at liquidations now," said Chief Investment Officer William Weinstein. He predicts that companies that had limited purchasing power last spring - when most retailers stock up for holiday sales - will go into early liquidation. For retailers that were healthy then, most will see out the Christmas season, he said.

Value City, for example, said in its bankruptcy filing that without enough money to keep its shelves well-stocked with enough inventory, it couldn't keep operations at a profitable level or keep borrowing money under its credit agreement with lenders.

Kirkland's Henes said changes to the U.S. bankruptcy law in 2005 are also encouraging retailers to liquidate rather than reorganize. One amendment gives trade creditors that supplied goods to a company within 20 days prior to its bankruptcy a so- called administrative claim. Such claims need to be repaid before most others, so lenders thinking about DIP financing need to factor in such payments now.

Another amendment requires companies to assume or reject leases within 270 days of their bankruptcy filing. That's shorter than previously, when judges granted routine extensions of lease-rejection deadlines. The new deadline is a particular disadvantage to retailers considering liquidation of some stores because it can take more than 270 days to determine which locations should survive, Henes said.